CBDT notifies new valuation rules for equity and compulsorily convertible preference shares for angel tax provisions

This Tax Alert explains the Notification [1] issued by Central Board of Direct of Taxes (CBDT) dated 25 September 2023 which amends valuation rules relevant for “angel tax” provisions.

The Finance Act 2023 amended Section 56(2)(viib) of the Income tax Act 1961, which taxes excessive premium received by a closely held company (CHC) from a resident (popularly known as “angel tax” provision) to include share investment made by a non-resident (NR), with effect from tax year 2023-24. The stakeholders raised concerns on increase in valuation disputes due to such an amendment. In response to such concerns, the CBDT announced certain amendments to valuation rules (i.e., Rule 11UA) vide Press Release dated 19 May 2023 and issued draft of amended Rule 11UA for public comments on 26 May 2023.

Post public consultation, the CBDT has now notified the final amended Rule 11UA with effect from 25 September 2023. The salient features of the amended Rule 11UA are as under:

• The amended Rule 11UA provides separate valuation mechanism for compulsorily convertible preference shares (CCPS) and also provides an option to adopt fair market value (FMV) of unquoted equity shares for determining FMV of CCPS.
  
• The erstwhile Rule 11UA prescribed two methods (viz. NAV or DCF ) for determining the FMV of equity shares issued to resident investors. The amended Rule 11UA provides five more methods of valuation for issue of unquoted equity shares or CCPS to NR investors viz. Comparable Company Multiple Method, Probability Weighted Expected Return Method, Option Pricing Method, Milestone Analysis Method and Replacement Cost Methods.
  
• The price matching facility as per draft rules for both resident and NR investors is extended to CCPS. In terms of such price matching facility, the price at which unquoted equity shares or CCPS are issued by CHC to notified NR entities/ venture capital funds (VCF)/ specified funds shall be adopted as FMV for the purposes of benchmarking equity and CCPS investments by both resident and NR investors, subject to compliance of certain conditions.
  
• In relation to price matching facility, price at which shares are issued to notified NR entities/ venture capital funds (VCF)/ specified funds shall be adopted as FMV, if receipt of consideration is within a window of 90 days before or after the date of issuance of shares subjected to valuation.
• The erstwhile Rule 11UA required merchant banker DCF valuation report as on the date of issue of shares. The amended Rule 11UA provides flexibility by making valuation report issued up to 90 days prior to the date of issue of equity shares or CCPS for computing FMV for investments by both resident and NR investors.
  
• Lastly, amended Rule 11UA introduces safe harbor limit of 10% for valuation of equity shares and CCPS for both resident and NR investments.
  

[1] CBDT Notification No. 81/2023